CHAPTER 3 ROLE OF LOGISTICS IN SUPPLY CHAINS

LEARNING OBJECTIVES

After reading this chapter, you should be able to do the following:

 Understand the contributions of logistics in improving organizational supply

chains.
 Appreciate how efficient and effective logistics management contributes to the
vitality of the economy and improves global competitiveness.
 Discuss the value-added roles of logistics on both a macro and micro level.
 Explain the relationship between logistics and other important functional areas in
an organization, including manufacturing, marketing, and finance and their unique
contributions to efficiency and effectiveness.
 Discuss the importance of management activities in the logistics function.
 Analyze logistics systems from several different perspectives to meet different
objectives.
 Determine the total costs and understand the cost tradeoffs in a logistics system.

CHAPTER OVERVIEW

Introduction

In spite of all the hype about the Internet, omni-channels, etc., successful organizations
must manage order fulfillment effectively and efficiently for competitive advantage and
profitability. Sophisticated front-end systems cannot stand alone in the competitive global
marketplace of today – “back office” execution is critical for customer satisfaction. In
fact, the speed of ordering via the Internet and other technologies exacerbates the need
for an efficient and effective logistics system that can deploy appropriate levels of
inventory, expedite completed orders to customers, and manage any returns.

It is important to delineate more explicitly the relationship between logistics management

and supply chain management. Supply chain management has been defined using a
pipeline analogy, with the start of the pipeline representing the initial supplier and the end
of the pipeline representing the ultimate customer. Another perspective on supply chain
management is to view it as a connecting network of the logistics systems and related
activities of all the individual organizations that are a part of a particular supply chain.

What is Logistics?
The term logistics has become much more widely recognized by the general public. In
the last 20 years, television, radio, and print advertising have lauded the importance of
logistics. Transportation firms, such as UPS, DHL, and FedEx, frequently refer to their
organizations as logistics companies and stress the importance of their service to overall
logistics success. The Persian Gulf War of the 1990s also contributed to increased
recognition of logistics because CNN news commentators’ frequent mention of the
3-1
IM Supply Chain Management: A Logistics Perspective
logistics challenges associated with the 7,000-mile long supply pipeline to support the
war effort in the Persian Gulf countries. Another factor contributing to the recognition of
logistics has been increased customer sensitivity not only to product quality but also to
the logistics service quality.

Logistics management, as defined in this text, encompasses logistics systems not only in
the private business sector but also in the public/government and nonprofit sectors. In
addition, service organizations such as banks, hospitals, restaurants, and hotels have
logistics challenges and issues, and logistics management is an appropriate and growing
activity for service organizations.

For the purposes of this text, the definition offered by the Council of Supply Chain
Management Professionals (formerly the Council of Logistics Management) is the most
appropriate. It states that logistics is ´ It states that logistics is “The art and science of
management, engineering, and technical activities concerned with requirements, design,
and supplying and maintaining resources to support objectives, plants, and operations.”

Logistics management is the most widely accepted term and encompasses logistics not
only in the private business sector but also in the public/government and nonprofit
sectors. For the 21st century, logistics should be viewed as part of organizational
management and has four parts: business, military, event, and service logistics. Each of
these subdivisions has some common characteristics and requirements such as
forecasting, scheduling, and transportation.

• Business logistics: That part of the supply chain process that plans, implements, and
controls the efficient, effective flow and storage of goods, service, and related
information from point of use or consumption in order to meet customer
requirements.

• Military logistics: The design and integration of all aspects of support for the
operational capability of the military forces (deployed or in garrison) and their
equipment to ensure readiness, reliability, and efficiency.

• Event logistics: The network of activities, facilities, and personnel required to

organize, schedule, and deploy the resources for an event to take place and to
efficiently withdraw after the event.

• Service logistics: The acquisition, scheduling, and management of the facilities/

assets, personnel, and materials to support and sustain a service operation or business.

All four subdivisions have some common characteristics and requirements such as
forecasting, scheduling, and transportation, but they also have some differences in their
primary purpose. All four, however, can be viewed in a supply chain context; that is,
upstream and downstream other organizations play a role in their overall success and
long-run viability.

Value-Added Roles of Logistics

3-2
IM Supply Chain Management: A Logistics Perspective
Five principle types of economic utility add value to a product or service. Included are
form, time, place, quantity, and possession. Generally, production activities are credited
with providing form utility; logistics activities with time, place, and quantity utilities; and
marketing activities with possession utility. Each will be discussed briefly.

Form or Transformation Utility: Form utility refers to the value added to goods through a
manufacturing or assembly process.

Place Utility: Logistics provides place utility by moving goods from production surplus
points to points where demand exists.

Time Utility: The economic value added to a good or service by having it at a demand
point at a specific time when it is needed.

Quantity Utility: Today’s business environment demands that products not only be
delivered on time to the correct destination but also be delivered in the proper quantities.

Possession Utility: Possession utility is primarily created through the basic marketing
activities related to the promotion of products and services.

Logistical Activities

The logistics definition indicates activities a logistics manager could be responsible for.
Below are some of those activities and what it encompasses:

 Transportation involves the physical movement or flow of raw materials or finished

goods and involves the transportation agencies that provide service to the firm.

 Storage involves two closely related activities: inventory management and

warehousing. A direct relationship exists between transportation and the level of
inventory and number of warehouses required. It is important to examine the trade-
offs related to the various alternatives in order to optimize the overall logistics
system.

 Packaging involves the necessary packaging needed to move the product to the
market safely and securely. Logistics managers must analyze the tradeoffs between
the type of transportation selected and its packaging requirements.

 Materials Handling is important to efficient warehouse operation and concerns the

mechanical equipment for short-distance movement of goods through the warehouse.

 Inventory Control includes assuring appropriate levels of materials are available and
certifying inventory accuracy.

3-3
IM Supply Chain Management: A Logistics Perspective
 Order Fulfillment consists of the activities involved with completing customer orders.
Order fulfillment concerns the total lead time from when the order is placed to actual
delivery in satisfactory condition.

 Forecasting involves the prediction of inventory requirement and materials and parts
essential to effective inventory control.

 Production Planning concerns the determination of the number of units necessary to

provide market coverage. The integration of production planning into logistics has
become increasingly popular in large companies to effectively forecast and control
inventory.

 Procurement concerns the availability for production of needed parts, components,

and materials in the right quantity, at the right time, at the right place, and at the right
cost including within the logistics area if it more effectively coordinates and lowers
costs for the firm.

 Customer Service levels play an important part in logistics by ensuring the customer
gets the right product, at the right time and place. Logistics decisions about product
availability and inventory lead time are critical to customer service.

 Facility Location is concerned with optimizing the time and place relationships
between plants and markets, or between supply points and plants. Site location
impacts transportation rates and service, customer service, inventory requirements,
and possible other areas.

 Other activities: Parts and service support is concerned with maintaining an adequate
channel to anticipated repair needs. Salvage and scrap disposal deals with reverse
logistics systems and channels in order to effectively and efficiently dispose of
containers and other scrap at the end of the distribution channel.

Logistics in the Economy: A Macro Perspective

The overall, absolute cost of logistics on a macro basis will increase with growth in the
economy. In other words, if more goods and services are produced, logistics costs will
increase. To determine the efficiency of the logistics system, total logistics costs need to
be measured in relationship to gross domestic product (GDP), which is a widely accepted
barometer used to gauge the rate of growth in the economy.

In 2014, logistics related costs accounted for 8.3% of GDP and totaled $1,449 billion.
This was an increase of 3.1% from the previous year due to increases in inventory costs,
warehousing costs, and transportation cost due to growth in the economy.

3-4
IM Supply Chain Management: A Logistics Perspective
The reduction in logistics cost as a percent of GDP has resulted from a significant
improvement in the overall logistics systems of the organizations operating in the
economy. This reduction in relative cost allows organizations to be more competitive
since it directly impacts the cost of producing goods.

Some additional understanding of logistics costs can be gained by examining the three
major cost categories – warehousing and inventory costs, transportation costs, and other
logistical costs. Warehousing costs are those associated with the assets used to hold
inventory. Inventory costs are all the expenses associated with holding goods in storage.
Carrying costs include interest expense (or the opportunity cost associated with the
investment in inventory), risk-related costs (obsolescence, depreciation), and service-
related costs (insurance, taxes). Transportation costs are the total national expenditures
for the movement of freight in the United States. The third category of logistics costs is
the administrative and shipper-related costs associated with managing logistics activities
and personnel.

The declining trend for logistics cost relative to GDP is very important to recognize. It
was related to the deregulation of transportation, which permitted much more flexibility
for carriers to purchase transportation services and allowed more flexibility for carriers to
adjust their freight rates and service in response to competition. A second factor
contributing to the trend has been the improved management of inventory levels with
more attention being focused on inventory investment and the technology available to
managers to make more effective inventory decisions. Finally, the focus by many
organizations on cash flow resulted in more emphasis on inventory turnover.

Logistics in the Firm: The Micro Dimension

The micro dimension of logistics examines the relationships between logistics and other
functional areas in an organization – marketing, manufacturing or operations, finance and
accounting, and others.

Logistics Interfaces with Manufacturing or Operations

Manufacturing efficiency is often based upon long production runs or scale with
infrequent manufacturing line setups or changeovers. The long run can result in higher
inventory levels of inventory for some finished products and limited supplies of others.
The best or optimal manufacturing decisions require managers to analyze the cost trade-
offs of longer production runs and their impact on inventory cost. Shorter production runs
with more efficient set-ups can provide flexibility to meet short run changes in demand.
Logistics and manufacturing also interface on the inbound side of production. For
example, a shortage or stock-out could result in the shutdown of a manufacturing facility
and an increase in production costs. The logistics manager should ensure that available
quantities of raw materials and components are adequate to meet production schedules
yet are conservative in terms of inventory carrying costs. Another activity at the interface
of logistics and manufacturing is industrial packaging, which many organizations treat as

3-5
IM Supply Chain Management: A Logistics Perspective
a logistics responsibility. In the context of manufacturing or logistics, the principal
purpose that industrial packaging serves is to protect the product from damage.
The interface between logistics and manufacturing is becoming more critical, given the
growth in procurement of raw materials and components from offshore sources and
sustainability issues. Also, many organizations today are making arrangements with
third-party manufacturers, “co-packers,” or contract manufacturers to produce, assemble,
or enhance some or all of the organization’s finished products. T

Logistics Interfaces with Marketing

Logistics has an important relationship with marketing that also necessitates
collaboration. The rationale is that physical distribution, or the outbound side of an
organization’s logistics system, plays an important role in the sale of a product. In some
instances, order fulfillment may be the key variable in the continuing sales of products;
that is, the ability to provide the right product at the right time to the right place in the
right quantities and the right cost can be the critical element in making a sale.

This section discusses the interfaces between logistics and marketing activities in each
principal area of the so-called marketing mix – price, product, promotion, and place.

Price: From a logistics perspective, adjusting quantity prices to conform to shipment sizes
appropriate for transportation organizations might be quite important.

Product: Another decision frequently made in the marketing area concerns products,
particularly their physical attributes. These changes impact container size and hence
container utilization and storage space requirements.

Promotion: Firms often spend millions of dollars on national advertising campaigns and
other promotional practices to improve sales. An organization making a promotional
effort to stimulate sales should inform its logistics manager so that sufficient quantities of
inventory will be available for distribution to the customer. Marketing can either “push”
the product through the distribution channel to the customer or “pull” it through.

Place: The place decision refers to the distribution channels decision, and thus involves
both transactional and physical distribution channel decisions.

Recent Trends: The most significant trend is that marketers recognize the strategic value
of place in the marketing mix and the increased revenues and customer satisfaction that
might result from excellent logistics service. As a result, many organizations have
recognized customer service as the interface activity between marketing and logistics
and have aggressively and effectively promoted customer service as a key element of the
marketing mix.

Logistics Interfaces with Other Areas

3-6
IM Supply Chain Management: A Logistics Perspective
While manufacturing and marketing are probably the two most important internal,
functional interfaces for logistics in a product-oriented organization, there are other
important interfaces. The finance and accounting areas have become increasingly
important during the last decade.

The impact that logistics and supply chain management can have upon return on assets
(ROA) or return on investment (ROI) is very significant. Logistics can positively impact
ROA in several ways. First, inventory is both a current asset on the balance sheet and a
variable expense on the income statement. Reducing inventory levels reduces the asset
base as well as the corresponding variable expenses, thus having a positive impact on
ROA. Second, transportation and warehousing costs can also influence ROA. If an
organization owns its warehouses and transportation fleet, they are fixed assets on the
balance sheet. If these assets are reduced or eliminated, ROA should increase. Similarly,
if an organization utilizes 3PL’s for warehousing and transportation, variable expenses
and asset levels will usually be impacted. Finally, the focus on customer servicecan
increase revenue. As long as the incremental increase in revenue is larger than the
incremental increase in the cost of customer service, ROA will increase.

Accounting is also an important interface for logistics. Accounting systems are critical
for providing appropriate cost information for analysis of alternative logistics options.
The recent interest in customer profitability and the related cost accounting systems such
as activity-based costing (ABC) has been beneficial to improving the quality of logistics
data and analyses. Accounting systems are also critical for measuring supply chain
tradeoffs and performance.

Logistics in the Firm: Factors Affecting the Cost and Importance of Logistics

This section deals with specific factors relating to the cost and importance of logistics.

Competitive Relationships
Frequently, competition is narrowly interpreted only in terms of price competition. While
price is certainly important, in many markets, customer service can be a very important
form of competition.

• Order Cycle: A well-accepted principle of logistics management is that order cycle

length directly affects inventory levels. Stated another way, the shorter the order
cycle, the less inventory required to be held by the customer. Order cycle can be
defined as the time that elapses from when a customer places an order until the order
is received.

• Substitutability: Substitutability very often affects the importance of customer

service. If a product is similar to other products, consumers may be willing to
substitute a competitive product when a stock-out occurs.
• Inventory Effect: By increasing inventory costs (either by increasing the inventory
level or by increasing reorder points), organizations can usually reduce the cost of lost

3-7
IM Supply Chain Management: A Logistics Perspective
 sales. In other words, an inverse relationship exists between the cost of lost sales and
inventory cost.
• Transportation Effect: Organizations can usually trade off increased transportation
costs against decreased lost sales costs.

Product Relationships
A number of product-related factors affect the cost and importance of logistics. Among
the more significant of these are dollar value, density, susceptibility to damage, and the
need for special handling.

• Dollar Value: The value of a product typically affects warehousing, inventory, and
transportation costs.
• Density: Another factor that affects logistics cost is density, which refers to the
weight/space ratio of the product.
• Susceptibility to Damage: The third product factor affecting logistics cost is
susceptibility to damage. The greater the risk of damage to a product, the higher the
transportation and warehousing cost.
• Special Handling Requirements: Some products might require specifically designed
equipment, refrigeration, heating, or strapping, which entail higher costs.

Spatial Relationships
A final topic that is extremely significant to logistics is spatial relationships, the location
of fixed points in the logistics system with respect to demand and supply points. Spatial
relationships are very important to transportation costs, since these costs tend to increase
with distance.

Logistics and Systems Analysis

A system is a set of interacting elements, variables, parts, or objects that are functionally
related to one another and the form a coherent group. The general tenet of the systems
concept is that the focus is not on individual variables but on how they interact as a
whole. The objective is to operate the whole system efficiently and effectively, not just
the individual parts.

Techniques of Logistics System Analysis

In this section, total cost analysis techniques for logistics are discussed. Only the more
basic models are examined.

Short-Run/Static Analysis
One general approach to total cost analysis for logistics is known as short-run analysis.
In a short-run analysis, a specific point in time or level of production is chosen, and costs
are developed for the various logistics cost centers described previously.

Long-Run/Dynamic Analysis
While short-run analysis concentrates on specific time or level of output, dynamic
analysis examines a logistics system over a long time period or range of output.

3-8
IM Supply Chain Management: A Logistics Perspective
Approaches to Analyzing Logistics Systems
The analysis of logistics systems frequently requires different views or perspectives of
logistics activities. The best perspective to take depends on the type of analysis that is
needed. For example, if an organization wants to analyze the long-run design of its
logistics system, a view of logistics that focuses on the organization’s network of node
and link relationships would probably be most beneficial. On the other hand, if an
organization is evaluating a change in a carrier or mode of transportation, it should
probably analyze the logistics system in terms of cost centers. In this section, four
approaches to analyzing logistics systems are discussed: (1) materials management versus
physical distribution, (2) cost centers, (3) nodes versus links, and (4) logistics channels.

Materials Management versus Physical Distribution

The classification of logistics into materials management and physical distribution
(inbound and outbound logistics) is very useful to logistics management or control in an
organization. Frequently, the movement and storage of raw materials in an organization is
different from the movement and storage of finished goods.

Cost Centers
Logistics usually includes transportation, warehousing, inventory, materials handling,
industrial packaging, etc. By examining these activities as cost centers, tradeoffs between
them can be analyzed to determine the overall lowest cost or highest service logistics
system, which represents a second approach to logistics system analysis.

Nodes versus Links

A third approach to analyzing logistics systems in an organization is in terms of nodes

and links. The nodes are fixed spatial points where goods stop for storage or processing.
Links represent the transportation network and connect the nodes in the logistics system.
The network can be composed of individual modes of transportation (rail, motor, air,
ocean, or pipeline) and of combinations and variations.

From a node-link perspective, the complexity of logistics systems can vary enormously.
A node system might use a simple link from suppliers to a combined plant and warehouse
and then to customers in a relatively small market area. At the other end of the spectrum
are large, multiple-product organizations with multiple plant and warehouse locations.
The complex transportation networks of the latter can include three or four different
modes and perhaps private as well as for-hire transportation.

The node-link perspective, in allowing analysis of a logistics system’s two basic

elements, represents a convenient basis for seeking possible system improvements. As
has been noted, the complexity of a logistics system often relates directly to the various
time and distance relationships between the nodes and the links and to the regularity,
predictability, and volume of flow of goods entering, leaving, and moving within the
system.

3-9
IM Supply Chain Management: A Logistics Perspective
Logistics Channels

A final approach to logistics system analysis is the logistics channel, or supply chain of
network organizations engaged in transfer, storage, handling, communication, and other
functions that contribute to the efficient flow of goods.

The logistics channel can be simple or complex. A simple channel in which an individual
producer deals directly with a final customer, is relatively simple. The individual
manufacturer controls the logistics flow since it deals directly with the customer.

A more complex, multi-echelon channel, with a market warehouse and retailers creates a
situation where control is more difficult because of the additional storage and
transportation provided by third-party organizations.

SUMMARY
• Logistics developed as an important area of business after World War II with several
phases of development.

• Logistics has become an important part of supply chain management. The

coordination and integration of the logistics systems of the organizations in a supply
chain facilitate the successful management of supply chains.

• While there are a number of different definitions for logistics, the definition
developed by the Council of Supply Chain Management Professionals is the primary
definition used in this text.

• Logistics is an area of management that has four sub-disciplines: business, military,

service, and event.

• On a macro basis, logistics-related costs have helped the U.S. economy maintain its
competitive position on a global basis.

• Logistics adds place, time, and quantity utilities to products and enhances the form
and possession utilities added by manufacturing and marketing.

• Logistics has an important system relationship to manufacturing, marketing, finance,

and other areas of the organization which aids in making organizations more efficient
and effective.

• Logistics activities, including transportation, inventory, warehousing, materials

handling, industrial packaging, customer service, forecasting, and others are
important components of supply chains.

• Logistics systems can be viewed or analyzed in several different ways including

materials management versus physical distribution, cost centers, nodes versus links,
and channels. All four approaches are viable for different purposes.
3-10
IM Supply Chain Management: A Logistics Perspective
• Logistics is frequently analyzed from a systems approach, which emphasizes cost and
service tradeoffs when changes are proposed. Either a short or a long-run perspective
can be used.

• The cost of logistics systems can be affected by a number of major factors, including
competition in the market, the spatial relationship of nodes, and product
characteristics.

ANSWERS TO STUDY QUESTIONS

1. Provide a definition of logistics and a rationale for why is it important in private

companies and public organizations?

2. Explain the importance of logistics important on a macro level and the

contributions of logistics to the economy?

3. How does logistics add value in the economy? How does logistics add value for
firms? What, if any are the differences?

4. Explain the relationship between logistics and supply chain management?

5. Compare and contrast the four major subdivisions of logistics discussed in this
chapter.

6. Discuss the relationship between manufacturing and logistics. What are the
tradeoffs between the two areas?

7. Physical distribution has a special relationship to marketing. What is the nature

of the relationship between logistics and marketing? Is the relationship
becoming more or less important? Why?

8. Logistics encompasses a relatively large number of managerial activities. Discuss

five of these activities and why they are important to logistics systems.

9. Why do companies analyze their logistics systems from perspective of nodes and
links?

10. What product characteristics affect logistics costs? Discuss the effects of these
characteristics on logistics costs.

3-11
IM Supply Chain Management: A Logistics Perspective